What is the impact of negative externalities on social welfare in a market economy?

Negative externalities occur when an activity causes harm to people or the environment who are not directly involved in that activity. This can lead to a situation where the true cost of a product or service is not reflected in its price. For example, if a factory pollutes a river, the local community suffers from health issues and reduced water quality, but the factory does not pay for these damages. As a result, resources may be used inefficiently, leading to lower overall social welfare because the negative effects are not accounted for in the market. Ultimately, addressing these externalities is important to ensure that the costs of production and consumption are shared fairly and society as a whole benefits.